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The FCA has recently published the final findings of its review of the motor finance sector. The review found that the way some commission arrangements are operating in motor finance may be leading to consumer harm on a potentially significant scale1. The FCA has started work to assess the options for policy interventions - including banning certain commission models - to address the potential harm it found.

The FCA is also not satisfied that firms are meeting regulatory requirements around customer communications and affordability assessments. It plans to follow up its concerns through supervisory work with individual firms.

This blog summarises the key findings of the FCA’s review and sets out the implications for firms, recognising that, whilst the findings and potential remedies of the FCA’s review are targeted at motor finance lenders and brokers, they raise issues of potential relevance to commission models, customer communications and creditworthiness assessments across the consumer credit sector.

Commission arrangements

The review found that certain commission arrangements create strong incentives for brokers to arrange finance at higher interest rates. This is because the amount of commission the broker receives increases with the interest rate the customer is charged; in these models, moreover, brokers have discretion to set this interest rate.

The FCA estimates that customers could pay £300m more annually in interest costs as a result of such models. It states that it is not clear why brokers have been afforded such discretion to “…in effect- pay themselves more commission”.

The FCA is now assessing the options for intervention. These include banning certain commission models or limiting broker discretion. It may also consider strengthening its Consumer Credit sourcebook (CONC) rules and guidance.

Consumer information

The FCA undertook a mystery shopping exercise to assess whether the information provided to customers is sufficiently timely and transparent. This found evidence that disclosures and explanations were often incomplete, and sometimes potentially misleading, The FCA is particularly concerned about the disclosure of commission, finding that only a small number of brokers disclosed to the customer that commission may be received for arranging finance.

Whilst the sample was small, and skewed towards independent retailers, the FCA is concerned that the problems identified may apply more generally. It plans to follow-up its concerns with individual firms and may consult on changes to CONC rules and guidance to strengthen existing provisions.

Creditworthiness assessments including affordability

The FCA is not satisfied that lenders are complying with its rules on assessing creditworthiness and affordability. In a significant number of cases (8 out of 20) firms did not provide the FCA with sufficient information to assess compliance with these rules. Furthermore, in a small number of cases, the FCA considered that firms appeared to focus more on the risk to themselves (credit risk) than affordability for the borrower.

New rules and guidance on assessing creditworthiness and affordability came into force in November 2018. The FCA will be assessing compliance with these new requirements this year.

Implications for firms

Commission models

Although the FCA is still considering its policy options, we see a strong likelihood that FCA will either issue a ban on certain commission models or limit broker discretion unless the industry acts quickly to address its concerns. The FCA states that “change is needed across the market”. In other markets the FCA has demonstrated a clear willingness to introduce strong remedies where it finds evidence of harm, or potential harm, to consumers. The price caps on payday lending and rent-to-own products (due to come into force in April 2019) are recent such examples.

Brokers may therefore want to assess the implications that a ban on certain commission types, or limits to their pricing discretion, would have on their business models. Commission structures, and what discretion, if any, they afford brokers, are matters lenders may want to review. The FCA states that there is an onus on lenders to show that any differences in commission are justified based on the work involved for the broker. Where brokers are afforded discretion to set interest rates, the rationale for this will need to be clearly identified and documented. Firms will also need to demonstrate that there are robust controls in place to address potential conflicts of interest and prevent poor outcomes for customers generally.

Customer communications

To meet FCA expectations, firms will need to satisfy themselves that their customer communications - including oral communications at the point of sale - are clear, fair and not misleading and that they do not emphasise the benefits of a product without also giving due prominence to relevant risks. Lenders will need to satisfy themselves that brokers are providing adequate pre-contractual disclosures, such that customers are able to assess whether they can afford the credit, as well as understand the key features of the product.

Firms will also need to satisfy themselves on whether commission arrangements are adequately disclosed, including where there is discretion to adjust the interest rate in order to earn more or where the amount of commission varies by lender or product.

Affordability assessments

As part of their creditworthiness assessment, firms are required to consider ‘affordability risk’ for the customer. The FCA is clear that firms should not lend unless they can demonstrate proper regard has been paid to the affordability risk in an individual case.

Supervisory scrutiny is likely to fall on firms’ approaches to affordability. In particular on whether their affordability assessments are adequate, bearing in mind that the higher the affordability risk to the consumer, the more rigorous the assessment is likely to need to be. Firms will need to show that documentation of these procedures provides sufficient detail on how the firm carries out its creditworthiness and affordability assessment and that a record of each decision to lend is kept.

Systems and controls

The FCA is concerned that while lenders may, in principle, have reasonable controls in place to monitor compliance by brokers, in practice these are not implemented in all cases. The FCA will expect lenders to demonstrate that their senior managers and boards are receiving robust management information (MI) that monitors compliance and highlights emerging risks and issues. Documentation of systems, controls and MI will also be essential in demonstrating to supervisors how the lender is discharging its broker oversight duties.

Conclusion

Lenders and brokers will need to assess the implications of a ban on commission arrangements or limits to broker discretion, given the scale of the potential harm uncovered by the FCA. The FCA will also expect firms to review their customer communications and approach to affordability to assess whether they are meeting existing regulatory obligations.

Firms across the wider consumer credit sector will need to take careful note of the FCA’s findings and review their policies, procedures and controls in relation to FCA’s expectations as to the fair treatment of customers, particularly where similarities between their practices and those highlighted by the FCA can be seen.

1The FCA found that the potential for consumer harm applies particularly to “Difference in Charge” (increasing and reducing) models and, to a lesser extent, some “Scaled” commission models.

Andrew Bulley - Partner, Centre for Regulatory Strategy, Deloitte

Andrew Bulley joined Deloitte in October 2016 from the Bank of England, where he was, most recently, the Director of Life Insurance Supervision. Between 2014 and 2016 he was a UK voting member of the Board of Supervisors of the European Insurance and Occupational Pensions Authority (“EIOPA”). In a career with the Bank of England and Financial Services Authority stretching over 27 years, Andrew has held senior roles in the supervision of life and general insurers, the London wholesale insurance underwriting and broking markets, retail and investment banks, asset managers, and IFAs.

Cindy Chan - Partner, Risk Advisory

Cindy Chan has over 20 years of financial services consulting and audit experience. She has extensive experience in supporting firms in regulatory risk assurance reviews and conduct risk projects including complaints handling, product development and governance, sales and suitability assurance, as well as Section 166 Skilled Person reviews and enforcement cases.

David Clements - Partner, Risk Advisory, Deloitte

David is a Partner in our FS Risk Advisory practice and part of our National Retail Conduct leadership team. He has 20 years’ experience in the financial services industry and has significant experience across Retail Banking, Wealth Management and Insurance markets. David specialises in advising on compliance and conduct risk issues, ranging from the design and development of conduct risk strategy and frameworks, leading our conduct assurance activity and leading many of our large scale complex regulatory transformation projects. David takes a pragmatic approach to the roles and projects he delivers, working closely with key stakeholders across both business and risk functions, to ensure practical and sustainable solutions are delivered.

Nicola Vincent - Director, Risk Advisory

Nicola is a director in our risk advisory practice. She has extensive knowledge in the conduct space built up through years at the regulator and has significant experience of advising consumer credit clients. She leads our consumer credit proposition.

Matthew is a governance, risk and conduct consultant within the Financial Services Risk Advisory Practice based in London. He advises clients in the financial services industry, with a particular focus and expertise on retail banking, consumer credit and insurance regulation.

Orla Hurst - Senior Manager, Centre for Regulatory Strategy

Orla is a Senior Manager in Deloitte’s Centre for Regulatory Strategy where she focuses on Conduct Regulation. She has extensive experience of working with financial services firms to help them understand the strategic and operational implications of changes to conduct regulation. She joined Deloitte in June 2017.

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